MH Corporate

Tuesday 9 June 2015

End of the corporate director… or not

Currently in the UK, companies are permitted to appoint directors who are corporate entities rather than individuals/natural persons. However, under the Companies Act 2006 all companies must have at least one director who is a natural person at all times.

Only just over one per cent. of UK companies use corporate directors. There are several reasons why it may be attractive or beneficial for companies to appoint corporate directors, such as administrative flexibility and efficiency. A corporate director could remain constant without the need to effect frequent appointments and resignations of individual directors. A parent company may also wish to directly control how its subsidiaries are run and may do so by it, or another group company, being appointed as a director of the subsidiaries.

However, the use of corporate directors can be, and sometimes is, open to misuse. For example, complex group ownership and control structures are often created, perhaps using shareholders and corporate directors in foreign jurisdictions as well. This makes it hard for others (including tax and other regulatory authorities) to ascertain the beneficial ownership of the UK company in question and also the individuals that control it. Such opaque structures are sometimes used for tax avoidance or tax evasion or to avoid liability or compliance with directors’ duties which would otherwise fall on the individual directors.

The use of corporate directors is not permitted in some other jurisdictions such as Germany, Australia, Switzerland and in some US states.

Against the backdrop of recent international impetus and commitment to promote greater transparency by companies, in July 2013 the UK’s Department for Business, Innovation & Skills (“BIS”) published a discussion paper which, amongst other things, proposed a prohibition on UK companies being able to appoint corporate directors. The discussion paper invited opinions on the proposals. The paper is available here.

BIS published the Government’s response to the discussion paper in April 2014 (“Response Paper”) under which it affirmed its intention to prohibit UK companies from appointing corporate directors. As such, the Small Business, Enterprise and Employment Act 2015 received Royal Assent on 26 March 2015 and the ban on corporate directors will come into force in October 2015.

The Response Paper noted that there was a broad consensus (which included views from non-governmental organisations, law enforcement agencies and other business organisations) that corporate directors should be prohibited in most instances. However, there were also arguments that there should be some exceptions to the ban in situations where there is a low risk of illicit activity or where the company in question operates under a more regulated framework (i.e. if its shares are listed on a public market).

In November 2014 BIS published a further discussion paper under which it put forward the proposed exceptions to a complete ban on corporate directors. This paper is available here. The possible exceptions include: companies which form part of a large group; public companies whose shares are listed on a regulated or prescribed market; other large non-listed public companies; certain large private companies; and companies in regulated sectors (i.e. charities or pension trustees). The period for responses to this paper has now ended but on 26 March 2015 BIS published a questionnaire seeking views on whether the Secretary of State should make a principles based exception to the ban on corporate directors. A copy of the questionnaire is available here. The consultation closes on 27 April 2015.

It is the Government’s intention to implement any exceptions and the scope of those exceptions in secondary legislation at the same time the general prohibition on corporate directors comes into force towards the end of 2015. Once the legislation comes into force, the ban on corporate directors will apply immediately to all new appointments and will apply to existing appointments 12 months later, so there is a grace period in which companies must remove or replace corporate directors with natural persons (unless any exemptions apply). Breach of the new rules will be a criminal offence.

There are no immediate plans by the Government to apply the ban on corporate directors to limited liability partnerships (“LLPs”) given that there is less evidence to show abuse carried out by LLPs through the use of corporate members. However, this position will be monitored by the Government after the new rules for companies come into force.

The case of Sugar Hut Group & Others v A J Insurance [2014] EWHC 3775 (Comm) considered the measure of business interruption losses to which the claimants were entitled following a serious fire at a well-known nightclub – the Sugar Hut Club in Brentwood, Essex (the “Club”). The case highlights the importance of full disclosure before inception of an insurance policy and gives an indication of how the courts will calculate business interruption losses and in particular the proper assessment of the overall loss of turnover.

The Facts

Following a fire on 13 September 2009, the Club was effectively unusable for a period of some 49 weeks until it eventually reopened on 25 August 2010. Very shortly after the Club reopened, it started to feature in a well-known TV show – The Only Way is Essex which significantly increased its national profile. The Court referred to this as the ‘TOWIE’ effect.

The Sugar Hut Group (“Sugar Hut”) initially issued proceedings against its insurers. The judge dismissed Sugar Hut’s claims on the grounds that there had been non-disclosure before inception of the insurance policy as well as breaches of warranties given to the insurers. Sugar Hut then commenced proceedings against its insurance broker A J Insurance (“AJI”) arguing that the reasons the judge had dismissed Sugar Hut’s claims against its insurers arose from AJI’s negligence/breach of duty to Sugar Hut. The claim against AJI was based on the amount Sugar Hut would have expected to recover from its insurers but for AJI’s negligence/breach of duty. AJI conceded liability before trial but the quantum of damage remained in dispute, in particular, how to calculate the overall loss of turnover during the period immediately following the fire until the Club reopened in August 2010.

The Judgment

The Court was presented with contrasting views from the forensic accountants instructed by the parties. The accountant instructed by Sugar Hut calculated the loss of turnover to be £2,626,769, which was based on an average between two perspectives: (1) an extrapolation of the Club’s turnover in the period before the fire which took into account the increase in turnover in the period before the fire and applied an uplift to calculate the projected lost turnover during the period immediately after the fire until the Club reopened; and (2) the actual turnover achieved after the Club re-opened for business.

The accountant instructed by AJI, presented a substantially lower figure of £1,883,311 by concluding that the Club’s turnover during the period immediately after the fire would have increased only by the relatively modest increase in the Consumer Price Index (“CPI”). He chose to ignore the actual turnover achieved after the Club re-opened for business.

The Court accepted that the figures showed an increase in turnover in the period before the fire and agreed to apply an uplift to these figures to reach a projected turnover in the equivalent weeks following the fire. However, it refused to take into account the turnover actually achieved after the Club re-opened. The Club was refurbished following the fire which meant that it was effectively a new club and the ‘TOWIE’ effect resulted in a substantial increase in the total number of visitors to the Club after it appeared on TV.

Comments

There are two main points to take away from this case:

in calculating the loss of turnover where a business has been interrupted, it is now unlikely that the courts will take into account the turnover after the business re-opens where substantial improvements have been made in the rebuilding process; and

it is difficult to assess business interruption losses and in particular the loss of turnover. There is a clear need to adduce convincing evidence to prove losses. It is also important to make full disclosure before the inception of any insurance policy and to comply with the warranties given.

The Department for Business, Innovation & Skills has published new regulations amending the share buyback process under the Companies Act 2006, in an attempt to clarify the previous amendments of 2013. With these latest changes having come into force with effect from 6 April 2015, we take a look at the regime’s evolution over recent years and the likely effects of the changes.

Background: The 2006 Act

Part 18 of the Companies Act 2006 (“Part 18”) sets out the procedure for share buybacks by a limited company. It imposes certain requirements in order to make a buyback lawful, relating to shareholder approval, timing of payment and how the purchased shares are treated. The most common reasons why a company may wish to buy back its shares are to return surplus cash to shareholders, increase net assets per share, enhance share liquidity, or provide shareholders with a way to exit the company.
When the original Part 18 came into force, it broadly followed the equivalent provisions under the Companies Act 1985, although importantly it removed the need for express authorisation for a buyback to be included in a company’s articles of association.

The Nuttall Review and 2013 amendments

In 2012 the Nuttall Review of Employee Ownership found that the regime was still overly burdensome and recommended several deregulatory changes to Part 18. These were aimed at removing barriers to the creation and uptake of employee ownership arrangements. Companies were found to be reluctant for their employees to receive shares, due to procedural requirements and fear of an inability to recover the shares later.

Regulations were produced which came into force in 2013 in response to the Nuttall Review, making the following amendments to the process:

an ordinary resolution was now sufficient to approve a buyback, rather than a special resolution (as previously required);

private and unlisted companies were allowed to hold treasury shares, rather than having to cancel repurchased shares immediately; and

in addition to buybacks out of distributable reserves, private companies were permitted to make small buybacks of shares out of cash, using the lower of £15,000 and 5% of their share capital in any financial year (but only where the company’s articles expressly permitted or where a special resolution was passed) (the “de minimis exemption”);

where a buyback was in relation to an employees’ share scheme (as defined in the 2006 Act), companies:

were able to authorise multiple share buybacks in advance without the need for a buyback agreement;

were able to finance buybacks out of capital with only the need for a solvency statement and special resolution; and

were able to finance buybacks in instalments.

The amendments simplified the procedure and brought increased flexibility by providing an easier route to divesting members of their shares, with less administrative burden. Notably, some of the most radical changes only related to employee share schemes, meaning that the effect of the provisions may be limited where, for instance, a departing manager does not hold his shares pursuant to such a scheme. This may therefore encourage companies to opt for an employee share scheme rather than the more traditional approach of employee benefit trusts, which can be expensive and cause administrative headaches themselves (for example they can lead to delays in complying with bank KYC requests).

2015 clarifications

The 2015 regulations have kept substantive changes to a minimum, with the main focus on clarifications to the 2013 amendments. The de minimis exemption introduced in 2013 is now stated as applying in respect of “the lower of £15,000 or the nominal value of 5% of the fully paid share capital calculated at the beginning of the financial year”. The regulations also clarify the accounting treatment of the de minimis buybacks (which should be the same as buybacks out of capital) and remove the ability to hold shares in treasury if bought back under the de minimis exemption.

It remains to be seen how popular these amendments will prove in encouraging employee share ownership, although the 2015 regulations will help both companies and advisers get to grips with the potential of the new regime. The increased flexibility is certainly welcome and private companies adopting new articles of association should consider including an express provision in respect of the de minimis exemption, to provide them with more choice when dealing with departing minority shareholders.